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Should Italian yields really be more Greek than Spanish?

It’s been nearly five months since the Italian general elections, with the result and the process of forming a coalition government eventually leading to the steepest selloff in BTPs we’ve seen for a long time, and the spread to bunds touching levels not seen since 2013.

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Economic Data Suggest Growth Rebound Forthcoming

Latest economic data signal a rebound in activity in the Eurozone – surveys signal 2.3% GDP growth – and we believe that growth in the second half will remain solid, with output growing above potential.

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Trade Turns into War

The first salvo in the trade war was fired when the US administration decided to impose tariffs on steel and aluminium imports and on USD 34 billion of imports from China, and to restrict Chinese investments in the US. The US’s trading partners retaliated by targeting specific imports from the US.

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The global economic outlook in 3 graphs

The economic environment is changing. The world Markit index level in the manufacturing sector is still showing growth (index at 53 above the threshold of 50) but it is trending downward since the peak of December 2017.

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Mexico, change of course with Lopez Obrador

The Mexican election result was consistent with expectations. Lopez Obrador was the favorite with a large margin and he has won with 53% at the first round. Lopez Obrador was expected to win during the last two elections but the lack of transparency in the election process prevents him to win these two electoral consultations.

This time Lopez Obrador was way ahead in polls and this was, at last, confirmed by the vote. He has won with 53% of the vote after the first round while the leader of the right coalition was only at 22% and the candidate of the incumbent PRI party was just at 16%.

With this large victory that could be expected by reading pre-election polls, no one can be surprised. Investors were aware of the changes that will come in Mexico. Therefore, the Mexican peso just moved temporarily on the downside.

The main change with Lopez Obrador is that his election creates a real political break in Mexico. The left has not been in power for decades and people wants a real change. It’s an interesting move. In many countries where a strong political movement has recently been observed, it has been a turning point towards greater populism and the right side of the political spectrum. In Mexico, they go to the left.

The candidate has been elected on his will to fight crime, corruption, poverty and to improve security in Mexico. The previous business friendly president has not been able to improve these items. It is also expected that he will be able to improve the purchasing power which stagnant.

In his first television speech, Lopez Obrador said that he wanted to respect Mexican institutions notably the central bank independence and the oil deals that were approved under the outgoing president. In other words, he doesn’t want to spontaneously make a revolution in the Mexican institutions. He said that he won’t nationalize companies nor quit NAFTA because it’s in Mexican interest to maintain the current strong links with both the US and the Canada. Mexico is too dependent on its economic partners to exit from this agreement.
The new Mexican president has discussed a lot with the business sector so the uncertainty on his program is limited for Mexican companies.

What to think on this election?

A first remark is that the new president will not be in charge before next December. It’s a very long process and it’s probably a bit inefficient. What will the current government do for the next 6 months? Probably nothing and if they do something it will not be necessarily consistent with the new president strategy. This is weird as negotiations on NAFTA will continue and are a major issue for Mexico.
During this period general elections will take place and probably the new president will a majority at both chambers.

The second remark is the possible divergence between economic stability, the government needs to maintain growth, and the application of the political program that was presented during the campaign. This arbitrage is a classic one especially when the government color changes. The process can be more brutal when the new president represents a party that has not been in power for a long-time period. We’ve seen that in France with François Mitterrand at the beginning of the 80’s (May 10, 1981). The left arrived in power and its supporters (ministers and president included) wanted a rapid change in everything. Many laws were passed and there was a real mess on the economic side with three devaluations of the French franc in 2 years. It was only in 1983 that the French government has changed its mind.
In Mexico, we must think at a process that could mimic this one. The new government must give guarantees to its electorate and political change are easier to put in place than a deep change on the economic side.
The good thing with Mexico is that this political process will be constrained by negotiations on NAFTA. This means that the risk of strong and long-lasting divergence is limited.
That’s also a reason to think that Lopez Obrador will not be a Chavist type of government?

The third remark will be on the possibility to reduce crime, corruption and poverty. All these are long term targets and the question is to know if the new government will be able to wait until the long-term? The risk therefore is to have strong operations that could have a destabilizing impact on the Mexican society.

Conclusion (which is necessarily temporary)

The interesting point with Mexico is that the Lopez Obrador victory was expected and there’s no surprise in it. Investors do know his program as they discussed a lot before the election day. This and the first soft speech of the new president explain the quite neutral move on financial markets.

There are two risks: one is that it will long before December when the new president will be in power. A lot of events can take place during the next 6 months notably because of the unpredictable neighbor of Mexico. Moreover, as Mexico is involved in an important negotiation on NAFTA there is a risk of divergence between the new president will and the conservative government in place. The second risk is the arbitrage between political commitments developed during the campaign and economic stability. The two are not necessarily consistent and can be a source of volatility on the perception of the Mexican outlook. We must be very attentive to these risks to understand the Mexican trajectory and its profile on financial market.

Philippe Waechter - Chief Economist - Ostrum Asset Management

EU's Future on the Agenda at Brussels Summit

With migration and trade exacerbating the existential reform questions that will drive European Union (EU) members together or apart, we think this week’s summit should be measured in binary terms: does it further EU cohesion (and help to withstand future shocks) or does it advance the forces of fragmentation?

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